Asian equity markets kicked off the week on a strong footing following a positive lead from Wall Street on Friday.
Bulls seem to have taken control after the S&P 500 rallied 1.6% on Friday and Treasury yields retreated further from the 3% critical level. The broad-based rally on Friday was led by the utilities, energy and technology sectors, suggesting that investors shrugged off concerns about rising interest rates. The Cboe’s VIX decline of 11.9% on Friday also indicates that the worst of the volatility is most likely behind us. However, investors shouldn’t take anything for granted, as this week is shaping to be a busy one, dominated by Fed Chair Jay Powell providing testimony to Congress and key data releases from the U.S. and Europe.
The FOMC’s latest minutes show that policymakers have grown a little more hawkish recently, but the trajectory on interest rates has not changed significantly according to CME’s FedWatch. Investors are pricing in a 62% chance of three rate hikes in 2018, suggesting that markets see Powell as a similar version of Yellen.
A gradual policy normalization with three rate hikes in 2018, is likely to be the base case scenario in Powell’s message. Any signal towards a fourth rate hike will likely disrupt markets, similar to the selloff witnessed last month.
The shape of the yield curve has also become a key indicator of risk. Although a flattening yield curve should signal slower economic growth, it has been enthusiastically welcomed by investors for the last couple of years. From November 2013 until late January 2018, the Treasury 30-5 year swap spread shrunk to 41 basis points, the lowest since 2007. This was accompanied by new records in equities. Any indication from Powell that Trump’s fiscal policies should be met with higher long-term interest rates will also be problematic for stocks. However, given where Treasury yields stand now, it doesn’t seem bond traders are worried.
On the data front, Thursday’s U.S. Core Personal Consumption Expenditure will be closely scrutinized given it’s the Fed’s preferred measure of inflation. A rise above 0.3% will again intensify fears that the U.S. central bank needs to accelerate rates at a faster pace. Investors will also be watching U.S. GDP second reading, durable goods orders, home sales, personal income & spending, manufacturing PMI, and consumer confidence levels.